Abstract & Overview
This paper examines the possible sources of inflation in Malawi’s economy since 1970s. Using vector autoregressive models of order two in changes of the variables, impulse response functions as well as error variance decomposition analysis, this study has established that changes in money supply, exchange rates, past values of inflation, recessions and booms were the main determinants of inflation. Further it is found that there was a clear differential impact between booms and recessions on inflation such that the impact of recessions was more pronounced though it was less persistent. These results are in line with those obtained from Malawi’s regional partners such as Zambia, Mozambique, Tanzania, Kenya and South Africa in related studies, however, this study is unique because it takes an advanced step forward to show using fairly sophisticated analysis that booms and busts present differential challenges to the macroeconomy and indeed inflation. Policies aimed at controlling money supply, interest rates as well as exchange rates are desired, as changes in these variables do generate significant changes in inflation levels. The implication of the established asymmetric effects of booms and busts on inflation is that inflation modelling must treat booms and slumps differently if the true impact of real output on inflation is to be precisely established empirically. Key words: Inflation, recessions and economic booms, vector auto regressions, generalized impulse response.